By Josh Newell

WASHINGTON (MNI) – Advanced economies have taken on much more debt
than generally reported, and this can affect countries’ sovereign
positions, according to economist Carmen Reinhart said in a presentation
at the International Monetary Fund Friday.

In a panel discussion at the IMF, titled ‘Financial Crises: Causes,
Consequences, and Policy Responses’, Reinhart, a professor at the
Harvard University John F. Kennedy School of Government, said in
prepared remarks, “When you look at both private and public debt we are
indeed in uncharted waters.”

Her main reasoning was that “true debts are much higher than meets
the eye;” she warns of “hidden debt”, debt that is not necessarily
public debt but can be seen as a possible government liability.

“There is also the issue of domestic debt, household debt. If we
focus only on public debt, we are missing the boat.”

Generally speaking, “The financial crisis morphs into a sovereign
crisis because the government begins to take on private debt,” she said.

In the context of the European debt crisis, Reinhart said, “When I
look at the end game in many countries, I think of the bank debt in
places like Ireland and in places like Spain, and part of the solution
involves restructuring,” though she did hedge this by stating a default
is not unavoidable in these countries.

“My own expectation is that the restructurings do not end with
Greece.”

–Josh Newell is a reporter with Need to Know News in Washington

** MNI Washington Bureau: (202) 371-2121 **

[TOPICS: M$U$$$,MI$$$$,M$X$$$,M$$CR$,MFU$$$,MFX$$$]

• US CPI rises 0.6% in August, core rises 0.1%. Core falls to 1.9% y/y from 2.1% prior
• US retail sales rise 0.9% in August; most of rise due to price of gasoline
• US industrial production falls 1.2% in August; much weaker than forecast
• University of Michigan consumer sentiment index rises to 79.2 from 74.3
• US business inventories rise 0.8% in July
• Protestors break into US embassies in Tunisia and Sudan
• Jean-Claude Trichet praises Draghi”s OMT plan
• US Marines being sent to Yemen to protect embassy
• ECB’s Asmussen warns against complacency on reforms from governments since interest rates have fallen
• IEA chief: Oil prices unbearable for consumers
• Monti/Merkel congratulate one another on a good week for the euro
• Egan-Jones cuts US rating to AA- from AA
• S&P closes up 0.4% at 1465
• US 10 year note rises 15 bp in yield to 1.87%

A very strong early session for risk assets with EUR/USD extending its gains to 1.3169 and cable to 1.6254 before some pre-weekend profit-taking set in.

USD/JPY and EUR/JPY were big movers today as short-positions in those pairs were covered and EUR/JPY broke through and close well above its 200-day moving average at 101.75. It reached 103.00 before closing at 102.82.

Closing levels:

EUR/USD 1.3122

USD/JPY 78.35

GBP/USD1.6230

AUD/USD 1.0555

EUR/JPY 102.82

Despite last week’s ECB news, EUR shorts on the CME only covered a small portion of their position as of the close of business on Tuesday.

Net Euro shorts were cut to 93,700 from 102,300 the prior weeks.

The market was short dollars versus everything else as of Tuesday.

Undoubtedly, many of those remain shorts were covered on this week’s surge to 1.3169.

Bu Yali N’Diaye

ARLINGTON, Va. (MNI) – U.S. Treasury Under Secretary for Domestic
Finance Mary Miller Friday indicated the administration will let the
November elections pass before it comes up with a plan for the future of
housing finance, but still expects one in the “reasonably near future.”

Asked how soon she expected a detailed proposal regarding Fannie
Mae, Freddie Mac and housing finance reform during a question and answer
session following a speech at an American Banker Regulatory Symposium
– assuming President Barack Obama wins the election — Miller said, “We
do need to get past the election.”

She added, “Once we get past that, I think there is more support
for some of the core tenants that have been discussed than perhaps is
appreciated.”

“So I hope that in the reasonable near future we can put out some
good ideas for everyone to get to work on that project,” she said.

Treasury is still working on programs that help address the legacy
problems by focusing on initiatives such as providing refinancing
opportunities or home modification opportunities, she said, noting quite
some progress on that front.

“That is forming the foundation for stabilization on the housing
market,” she commented.

“You can then turn to the future of housing market finance, and I
think the key there is going to find strong bipartisan support for a
plan that we can introduce,” Miller continued.

Asked about an update on the designation of systematically
important financial institutions, Miller pointed out that the Financial
Stability Oversight Council laid out a three-stage designation process
in the spring, adding, “the regulators are in the middle of working on
the stages.”

In other comments, Miller showed no sympathy for Federal Deposit
Insurance Corporation Director Thomas Hoenig’s view on Basel 3. He said
at the same conference earlier that the U.S. should reject Basel 3
capital standards unless they are revisited and their implementation is
delayed.

He proposed instead a simpler alternative.

“I think we need to let the regulators do their work,” she said. “I
think we need to take some time with Basel 3,” she said. “We’ve
certainly been supportive of it in the United States.”

** MNI **

[TOPICS: MK$$$$,MAUDS$,M$U$$$,MGU$$$]

Sean Egan doing his mischief again…

I don’t expect much reaction as Egan-Jones is seen as a bit “idiosyncratic”.

WASHINGTON (MNI) – Rating agency Egan-Jones Friday cut the United
States’ sovereign credit rating to ‘AA-’ from ‘AA’ citing its opinion
that the third round of quantitative easing announced by the Federal
Reserve Thursday “will stoke the stock market and commodity prices, but
in our opinion will hurt the US economy and, by extension, credit
quality.”

Below is the text of the summary of Egan-Jones rating action:

Up, up, and away – the FED’s QE3 will stoke the stock market and
commodity prices, but in our opinion will hurt the US economy and, by
extension, credit quality. Issuing additional currency and depressing
interest rates via the purchasing of MBS does little to raise the real
GDP of the US, but does reduce the value of the dollar (because of the
increase in money supply), and in turn increase the cost of commodities
(see the recent rise in the prices of energy, gold, and other
commodities).

The increased cost of commodities will pressure profitability of
businesses, and increase the costs of consumers thereby reducing
consumer purchasing power. Hence, in our opinion QE3 will be detrimental
to credit quality for the US. Some market observers contend that a
country issuing debt in its own currency can never default since it can
simply print additional currency.

However, per Reinhart & Rogoff’s ” This Time Is Different: Eight
Centuries of Financial Folly ” , p.111, 70 out of 320 defaults since
1800 have been on domestic (i.e., local currency) public debt. Note, US
funding costs are likely to slowly rise as the global economy recovers
or the FED scales back its Treas. purchases (75% recently).

From 2006 to present, the US’s debt to GDP rose from 66% to 104%
and will probably rise to 110% a year from today under current
circumstances; the annual budget deficit is 8%. In comparison, Spain has
a debt to GDP of 68.5% and an annual budget deficit of 8.5%. We are
therefore downgrading the US country rating from “AA” to “AA-”.

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MFU$$$,MR$$$$,MMUFE$]

One of the upshots of this week’s events (and last week’s, accounting for OMT) has been a move out of safe-haven bunds and Treasuries and into higher-risk stocks, commodities and currencies and out of safe-havens like JPY and CHF.

The rise in yields in bunds and Treasuries has made the dollar and euro that much more attractive to investors. In an effort to boost economic growth, central bankers are keen to move money off the relative safety of the sidelines, as represented by bonds and into the economy, as represented by stocks. As risk rises, EUR/JPY and USD/JPY tend to tag along, with firmer yields helping Japanese investors and carry traders gain a margin for safety when holding those positions.

–White House Budget Office: Cuts ‘Never Intended To Be Implemented’
–Cuts To Have ‘Devastating Impact’ On Defense, Domestic Programs
–Administration Still Wants ‘Balanced’ Deal To Replace Sequestration
–Deficit Deal Could Replace ‘All Abritrary Cuts’ That Are Required

By John Shaw

WASHINGTON (MNI) – The White House’s Office of Management and
Budget said Friday that if the $110 billion in across-the-board spending
cuts for the 2013 fiscal year go forward they will compel deep cuts in
more than a thousand defense and domestic spending programs.

In a report mandated by Congress, OMB said the sequestration
process would have a “deeply destructive impact” on virtually all parts
of the federal budget.

The 394-page OMB report outlines cuts of up to 10% in 1,200 federal
government programs. Overall, the sequestration process requires $55
billion in domestic cuts and $55 billion in defense cuts for FY’13.

The OMB report said the threat of across-the-board spending cuts
was developed last year to forge a bipartisan budget agreement, adding
the actual cuts were “never intended to be implemented.”

The OMB report said specific cuts for FY’13 are “dictated by a
detailed statutory scheme” that allows for very limited flexibility by
the administration.

The OMB report said the sequestration process would have a
“devastating impact” on key programs in both the defense and domestic
portions of the federal budget.

The sequestration process, the OMB said, is “not a substitute” for
a responsible and balanced deficit reduction package. Such a package
could be used to replace “all the arbitrary cuts” that are required by
the sequestration process.

At a briefing, senior administration officials said policymakers
should spend time and energy trying to finds ways of replace the
sequester.

“Sequestration is a blunt and indiscriminate instrument,” one
official said, adding the administration “does not support” implementing
the cuts, but wants to find a deficit reduction alternative to avoid
having to make them.

“They (the threatened across-the-board spending cuts) were
intended to drive both sides to a consensus,” the official said.

The White House report was mandated by Congress to spell out how
individual programs will be cut if the $110 billion in across-the-board
spending cuts in FY’13 go forward.

** MNI Washington Bureau: (202) 371-2121 **

[TOPICS: M$U$$$,MFU$$$,MCU$$$]

WASHINGTON (MNI) – The following is the text of the introduction to
the report by the White House Friday laying out the impact of the
across-the-board cuts — also known as sequestration — that are set to
kick-in at the beginning of next year.

“This report, which provides preliminary estimates of the
sequestration’s impact on more than 1,200 budget accounts, makes clear
that sequestration would have a devastating impact on important defense
and nondefense programs,” the White House said:

The Sequestration Transparency Act of 2012 (STA) (P.L. 112-155)
requires the President to submit to Congress a report on the potential
sequestration triggered by the failure of the Joint Select Committee on
Deficit Reduction to propose, and Congress to enact, a plan to reduce
the deficit by $1.2 trillion, as required by the Budget Control Act of
2011 (BCA). In response, the Office of Management and Budget (OMB) is
issuing this report based on assumptions required by the STA. The report
provides Congress with a breakdown of exempt and non-exempt budget
accounts, an estimate of the funding reductions that would be required
across non-exempt accounts, an explanation of the calculations in the
report, and additional information on the potential implementation of
the sequestration.

In August 2011, bipartisan majorities in both the House and Senate
voted for the threat of sequestration as a mechanism to force Congress
to act on further deficit reduction. The specter of harmful
across-the-board cuts to defense and nondefense programs was intended to
drive both sides to compromise. The sequestration itself was never
intended to be implemented. The Administration strongly believes that
sequestration is bad policy, and that Congress can and should take
action to avoid it by passing a comprehensive and balanced deficit
reduction package.

As the Administration has made clear, no amount of planning can
mitigate the effect of these cuts. Sequestration is a blunt and
indiscriminate instrument. It is not the responsible way for our Nation
to achieve deficit reduction. The President has already presented two
proposals for balanced and comprehensive deficit reduction. It is time
for Congress to act. Members of Congress should work together to produce
a balanced plan that achieves at least the level of deficit reduction
agreed to in the BCA that the President can sign to avoid sequestration.
The Administration stands ready to work with Congress to get the job
done. The estimates and classifications in the report are preliminary.
If the sequestration were to occur, the actual results would differ
based on changes in law and ongoing legal, budgetary, and technical
analysis. However, the report leaves no question that the sequestration
would be deeply destructive to national security, domestic investments,
and core government functions. Under the assumptions required by the
STA, the sequestration would result in a 9.4 percent reduction in
non-exempt defense discretionary funding and an 8.2 percent reduction in
non-exempt nondefense discretionary funding. The sequestration would
also impose cuts of 2.0 percent to Medicare, 7.6 percent to other
non-exempt nondefense mandatory programs, and 10.0 percent to non-exempt
defense mandatory programs.

The percentage cuts in this report, and the identification of
exempt and non-exempt accounts, reflect the requirements of the laws
that the Administration is applying. With the single exception of
military personnel accounts, the Administration cannot choose which
programs to exempt, or what percentage cuts to apply. These matters are
dictated by a detailed statutory scheme. The Administration does not
support these cuts, but unless Congress acts responsibly, there will be
no choice but to implement them.

On two separate occasions, the President has put forward proposals
to responsibly avoid these arbitrary cuts: first, in the President’s
Plan for Economic Growth and Deficit Reduction that was presented to the
Joint Committee in September 2011, and second, in the President’s fiscal
year (FY) 2013 Budget. Both of these plans made tough choices to reduce
the deficit with a balanced package of spending cuts and revenue
increases, with the FY 2013 Budget proposing $2.50 in spending cuts for
every $1 in new revenue. Both plans included over $4 trillion in deficit
reduction, including the deficit reduction in the BCA itself, far
exceeding the amount that would have been required of the Joint
Committee to avoid sequestration. Importantly, the President’s proposals
would ensure that deficit reduction is achieved in a way that asks the
top two percent of Americans to shoulder their fair share of the burden.
Instead of working to enact a balanced deficit reduction package to
avoid the threat of sequestration, some Members of Congress are focusing
on unbalanced solutions that rely solely on spending cuts or try to
alter only part of the sequestration. These proposals do not represent
realistic, fair, or responsible ways to avoid sequestration. Unlike the
President’s proposals, they are sharply contrary to the conclusions of
numerous independent and bipartisan groups that recommend a
comprehensive, balanced deficit reduction package comprised of both
spending cuts and revenue increases.

The House Republican FY 2013 Budget Resolution and the House
Republican Sequester Replacement Reconciliation Act of 2012 (SRRA)
represent particularly irresponsible approaches to addressing
sequestration. The BCA has already locked in almost $1 trillion of
discretionary spending reductions over 10 years, bringing nonsecurity
discretionary spending down to the lowest level as a share of the
economy since the Eisenhower Administration. The House Republican
proposals would further cut nondefense discretionary spending, refuse to
raise any revenue from the top two percent for deficit reduction, and
fail to address the Medicare sequestration. These proposals would shift
the burden of deficit reduction onto the middle-class and vulnerable
populations and represent the wrong choices for the Nation’s long-term
growth and prosperity.

This report, which provides preliminary estimates of the
sequestration’s impact on more than 1,200 budget accounts, makes clear
that sequestration would have a devastating impact on important defense
and nondefense programs. While the Department of Defense would be able
to shift funds to ensure war fighting and critical military readiness
capabilities were not degraded, sequestration would result in a
reduction in readiness of many non-deployed units, delays in investments
in new equipment and facilities, cutbacks in equipment repairs, declines
in military research and development efforts, and reductions in base
services for military families.

On the nondefense side, sequestration would undermine investments
vital to economic growth, threaten the safety and security of the
American people, and cause severe harm to programs that benefit the
middle-class, seniors, and children. Education grants to States and
local school districts supporting smaller classes, afterschool programs,
and children with disabilities would suffer. The number of Federal
Bureau of Investigation agents, Customs and Border Patrol agents,
correctional officers, and federal prosecutors would be slashed. The
Federal Aviation Administration’s ability to oversee and manage the
Nation’s airspace and air traffic control would be reduced. The
Department of Agriculture’s efforts to inspect food processing plants
and prevent foodborne illnesses would be curtailed. The Environmental
Protection Agency’s ability to protect the water we drink and the air we
breathe would be degraded. The National Institutes of Health would have
to halt or curtail scientific research, including needed research into
cancer and childhood diseases. The Federal Emergency Management Agency’s
ability to respond to incidents of terrorism and other catastrophic
events would be undermined. And critical housing programs and food
assistance for low-income families would be cut.

Because there is still time for Congress to act to prevent these
cuts, and because of the need to avoid unnecessarily diverting scarce
resources from other important Government functions, OMB issued guidance
to agencies in July instructing them to continue normal spending and
operations. Until Congress acts, the Administration will continue to
work, as necessary, on issues related to the sequestration and its
implementation. OMB will issue additional guidance regarding
sequestration in the months ahead as necessary.

However, no amount of planning can mitigate the significant impact
of the sequestration. The destructive across-the-board cuts required by
the sequestration are not a substitute for a responsible deficit
reduction plan. The President has already presented two proposals for
balanced and comprehensive deficit reduction, but under our
Constitution, he cannot do the job alone. Congress also needs to act.
The Administration remains ready to work with Congress to enact a
balanced plan that achieves at least the level of deficit reduction
agreed to in the BCA, and cancels the sequestration.

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: M$U$$$,MGU$$$,MFU$$$,M$$CR$]

By Yali N’Diaye and Denny Gulino

ARLINGTON, Va. (MNI) – Treasury Under Secretary Mary Miller Friday
warned that congressional opponents of the Dodd-Frank financial
regulatory reforms are taking a “dangerous” stance, ignoring the lessons
taught by the crisis that could have been a second Great Depression.

Speaking to the American Banker Regulatory Symposium, Miller
recounted her own view of the crisis on a Sunday four years ago with her
staff at T. Rowe Price assembled.

“We were still absorbing the extraordinary news that Fannie Mae and
Freddie Mac had been placed into conservatorship,” with a Lehman Bros.
bankruptcy filing pending. “We had no idea what lay ahead.”

Over the next two days Lehman did file for bankruptcy protection,
Merrill Lynch was sold to Bank of America, AIG began to crumble,
Washington Mutual and Wachovia were forced to merge with stronger
partners.

“Every corner of our financial system was ravaged by crisis,” she
said. “Markets were in total disarray. Investment grade credit ratings
lost their meaning.”

But Dodd-Frank’s critics “apparently have forgotten what happened
when huge amounts of risk built up inside our financial system.”
“Perhaps they must have little memory of the events that unfolded just
four short years ago — when major financial institutions were falling
like dominos.”

Considering “the lost wealth. The lost businesses. The lost jobs,”
she declared, “This line of thinking is dangerous.”

Like acting FDIC Chairman Martin Gruenberg said earlier at the same
conference, and as have Federal Reserve officials also said in recent
days — addressing the politically potent source of a lot of complaints
– Dodd-Frank “ensures that community banks and other small lenders are
not subject to many of the requirements that mainly affect larger
institutions,” she said.

“Dodd-Frank works to protect small banks from excessive supervisory
burdens,” she continued. The new Consumer Financial Protection Bureau
“is required by law to consider the impact of proposed regulations on
the smaller banks.”

With the five largest banks, which control a little more than half
of U.S. banking assets, still the frequent target of congressional,
investor and public criticism, much of the lobbying against Dodd-Frank
has been on the shoulders of smaller banks and their trade groups.

Miller said that the core principles of regulators and the Treasury
Department still include not backing away “from our fundamental
responsibility of making sure our financial system is safe.” She also
said that the new regulations being formulated often can not be made
simple and still be “smart.”

“It is hard to write a very detailed rule,” she said of the Volcker
Rule separating proprietary trading from traditional banking services
backed by federal insurance, particularly when proposals attract 18,000
comment letters “addressing all kinds of issues and concerns.” So while
striving for simplicity, “We are mindful of the need to have smart rules
that are responsive to the unique needs of our financial system.”

** MNI Washington Bureau: 202-371-2121 **

[TOPICS: MK$$$$,MAUDS$,M$U$$$]

• Most unemployment cyclical, part is structural

Raskin is a Fed Governor, speaking at a conference in Philadelphia.

FRANKFURT (MNI) – European Central Bank President Mario Draghi may
be prematurely celebrating the success of the central bank’s new bond
buy program, as Spain continues to hold out against a bailout deal and a
fresh rift on the Governing Council is emerging over the conditions that
would be attached to the sovereign debt purchases.

“There have already been positive results. The announcement of the
facility has contributed to raising confidence in the euro area, and in
the euro across the world,” Draghi was quoted saying in Friday’s edition
of Germany’s Sueddeutsche Zeitung. “Fund managers are bringing their
money back to Europe. This is good for the euro area economy.”

Later on Friday, at a press conference after the informal Eurogroup
meeting in Cyprus, Draghi was asked how long he thought the market
tranquility would last in the absence of any actual bond purchases by
the ECB. “If we continue going in this way, one has to be optimistic,”
he replied.

Governing Council member Panicos Demetriades on Thursday went a
step further, suggesting that the ECB might not have to buy a single
bond. “A central bank has this wonderful ability that no other player in
the market has when it says ‘I’m going to do whatever it takes,’ and
everyone believes that. In the end they may do nothing,” Demiatriades
said.

The ECB’s new promise of bond market intervention has sent
refinancing costs for Spain tumbling. On Friday, yields on Spanish
10-year bonds stood at 5.64%, down from a high of 7.57% on July 24.
Should refinancing costs stabilize at this level, Spain might well seek
to avoid a bailout deal that would be the condition for any future ECB
interventions.

“I still don’t know the conditions or whether it is necessary for
Spain to request it,” Spanish Prime Minister Mariano Rajoy said on
Thursday. “We will see how the risk premium develops and the financing
differentials ahead.”

Both the ECB and the International Monetary Fund on Friday denied
media reports that they were in negotiations with Spain over a E300
billion bailout program. Spain is doing its part trying to convince
markets that its lower borrowing cost is justified. On Friday, Spain
promised to present a new set of structural economic reforms by the end
of the month.

It may be overly optimistic to assume that Spanish yields will
stabilize at the current level in the absence of a bailout deal. With a
host of redemptions due in October, markets have been betting on a
bailout deal by mid-October. Should such an accord prove elusive,
borrowing costs could well shoot through the roof again in a few short
weeks.

Were that to happen, it would not be the first time Draghi had
claimed success for the ECB’s policies prematurely. Draghi was extremely
optimistic about the impact of the three-year LTROs in December and
February. But after short-term relief, sovereign refinancing costs
resumed their rise with a fury. Bank lending has also remained subdued.

A key condition for “everyone” to believe in the ECB’s resolve – as
Demetriades suggested – is that the Governing Council is seen as almost
fully behind the program. Draghi has thus far managed to get the Council
behind the new policy with the sole exception of Bundesbank President
Jens Weidmann.

However, the Council appears to be divided over how strong the
conditions on any new bailout program would have to be to trigger
central bank intervention. The ECB said that it will only consider
buying the bonds of countries that are either under a full EFSF/ESM
macroeconomic adjustment programme or a precautionary programme.

However, the precise conditions attached to any program will be
agreed by governments, the European Commission and the IMF, leaving
considerable wriggling room to make support available without many
additional requirements. The ECB has retained the right to withhold bond
market support should it be dissatisfied with the program, noting that
EFSF/ESM support is a “necessary but not sufficient” condition to
trigger bond buys.

Recognizing that Spain has already implemented key reforms, some
Council members are willing to give Madrid the green light without
requiring additional measures under a new EFSF/ESM program.

“The idea is not to add austerity to austerity,” Executive Board
member Benoit Coeure said last week. “These countries have already taken
many measures that go in the right direction. There will not necessarily
be additional demands” on governments. Similarly, Council member Ignazio
Visco said Thursday that conditionality of the plan is “not linked to a
series of measures to be taken but to progress in a certain direction.”

Council member Ardo Hansson, on the other hand, stressed that
should any program turn out “not to be strong enough, that is an ex-ante
reason to say ‘no they won’t get the support from the ECB’.” Similarly,
Executive Board member Joerg Asmussen said earlier this week that tough
reforms would be required. On Friday, he stressed that there was nothing
automatic about the ECB buying Spanish debt.

Such public disagreement over future ECB policy will only sow
uncertainty and do little to deter markets from testing the central
bank. Chances are that the ECB will still have to prove its mettle by
actual intervention.

–Frankfurt newsroom +49 69 72 01 42; e-mail: jtreeck@marketnews.com

[TOPICS: MT$$$$,M$$EC$,M$X$$$,M$$CR$,MGX$$$,M$S$$$]

• Deep automatic spending cuts would be deeply destructive to national security, domestic “investments” and core governmental functions
• Urges Congress to avoid spending cuts, pass tax hikes
• Spending cuts would result in a reduction of readiness of non-deployed military units, delay new equipment orders

Report was sue several weeks ago.

By Yali N’Diaye

ARLINGTON, Virginia (MNI) – A day after the Federal Reserve took
yet another strong step to support the economy, a banking regulator and
former Fed official expressed concerns about the risky incentives such
policies are creating.

“I worry about the next incentive we are creating for the next
bubble,” said Federal Deposit Insurance Corporation Direct Thomas Hoenig
during a discussion at an American Banker Regulatory Symposium Friday.

The Fed’s policymaking Federal Open Market Committee Thursday said
interest rates are likely to remain close to zero for an even longer
period of time and will attempt to help mortgage rates stay low by
buying agency mortgage-backed securities.

Hoenig — the former Kansas City Fed President who had been a
regular dissenter against FOMC’s decisions — said the very low interest
rates “distort the market” as well as the allocation.

In other comments, Hoenig reiterated the need to break down large
banks while the case is still “strong.”

Earlier Friday, Hoenig came up with yet another plan to make the
U.S. financial sector safer, calling the U.S. to reject Basel III unless
it was revisited and its implementation was delayed.

“I believe the (Basel) Committee should agree to delay
implementation and revisit the proposal,” Hoenig said. “Absent that, the
United States should not implement Basel III, but reject the Basel
approach to capital and go back to the basics.”

Hoenig proposed instead “tangible equity to tangible assets ratio”
as a better measure to assess capital adequacy.

“The starting point for any discussion of an acceptable level of
tangible equity for all banking firms should be well above the 3-1/4
percent level now implied by the Basel III proposal,” he said.

Asked during the discussion which actual minimum level he
envisioned, he said 10% at least.

** MNI **

[TOPICS: M$U$$$,MMUFE$,MGU$$$,MK$$$$]

EUR/USD has taken on a slightly easier tone, dipping back just below the 1.3100 level briefly. Equity markets are well-below earlier highs Up just 0.3% after having been up 0.9% earlier in the day. Not a big deal considering how far we’ve run this week.

More small bids are seen in the 1.3080 area, traders report.

By Stephen Sandelius

PARIS (MNI) – The first major test of the new French government’s
fiscal resolve will be its 2013 budget, to be released in two weeks.
Many analysts believe it will not be ambitious enough.

Whether the Socialists succeed in slashing the public deficit from
4.5% of GDP this year to 3% next year will not be known until early
2014. But the preliminary parameters suggest the government is skating
on thin ice.

President Francois Hollande confirmed Sunday his strategy of taxing
mainly big business and wealthy households to boost revenues by E20
billion next year while freezing outlays in nominal terms, except for
pensions and health care, through spending cuts of E10 billion.

The budget assumption for GDP growth will most likely be cut to
0.8% from 1.2% previously, Hollande revealed.

“This growth forecast is clearly very optimistic in light of the
planned fiscal tightening,” said analyst Jean-Christophe Caffet of
Natixis.

Such scepticism is widespread. A survey of 18 leading banks and
think tanks published this week by the French business daily Les Echos
gave an average growth forecast of 0.3% in a range from -0.2% (Citibank)
to +1.3% (HSBC – in July). Few expect a bull’s eye for the deficit
target.

“In our view, France will make every effort to deliver on its
target, even if that implies additional tax and spending measures next
year to plug the gap, but the 3% of GDP target will likely be missed,”
analysts at UBS said in a research note, predicting 0.4% growth and a
deficit of 3.4%.

A common concern is that France will be dragged into the vicious
circle of some of the weaker peripheral Eurozone economies, in which
rapid budget consolidation undermines growth, dampening revenues in turn
and thus requiring even deeper spending cuts or steeper tax hikes.

Some Socialists share this fear and would prefer to see the 3%
deficit target pushed back a year. But France has signed on to the EU
fiscal compact, and financial markets appear ready to punish any
backsliding. “The government has no choice,” Caffet said.

Having rescinded the VAT hike planned by the previous government,
the Socialists aim to ramp up income tax revenue by maintaining the
freeze on tax brackets in nominal terms, introduced by the previous
government, so that most households will pay more due to the inflation
impact on their earnings. A new bracket of 45% will be added for annual
earnings over E150,000 and an “exceptional” rate of 75% imposed above E1
million.

Investment returns, which have traditionally enjoyed more favorable
rates in France, will now be treated the same as salaries via a
withholding tax. The wealth tax will be hiked, with exemptions for
primary residences and life insurance assets. Some tax shelters are
likely to be restricted and the overall ceiling on tax exemptions
lowered from E18,000 to E10,000.

Behind the Socialists’ slogan of “fiscal justice” there is also the
idea that investment earnings go primarily into savings, in contrast to
take-home pay, which is usually spent by the end the month – if not
before.

The strategy has been carefully calibrated to have “the least
possible impact on economic activity at every level,” explained BNP
Paribas analyst Dominique Barbet.

Similarly, the extra E10 billion burden on business will fall
primarily on large corporations in order to favor small firms,
especially exporters. Dividend taxes will be hiked to encourage
companies to channel more profits toward investment, and tax shelters
will be pared, notably tax-free overtime for firms with more than 20
employees.

Barbet expressed confidence that in light of the “expertise” the
Finance Ministry has acquired in fine-tuning the tax system, the budget
to be unveiled on September 28 will be “completely consistent” with the
growth assumption and the deficit target. But he acknowledged the
inherent risks involved in projecting revenues after an overhaul of the
tax system.

Predicting GDP growth well before the budget year has started is a
also a particularly delicate excercise at a time when the economic
environment is shifting rapidly, Barbet reminded. But he conceded that
fiscal tightening “equivalent to two percentage points of GDP makes 0.8%
growth unlikely to be achieved next year.”

Caffet had penciled in 0.7% growth – before taking into account the
planned tightening, which could amputate close to 1.5 points from GDP
growth, he reckoned. On that basis, Hollande’s 0.8% would imply
“pre-tax” growth above 2%.

“Do we really believe that even without the consolidation France
would rebound with GDP growth around 2% when the world around us is
collapsing?” Caffet asked rhetorically, citing the slowdown in most
emerging economies, the “fiscal cliff” looming in the United States, the
recovery of the euro and the relentless consolidation throughout the
Eurozone, which will weigh on investment and consumption.

Analyst Manuel Maleki of ING also fears the austerity plan will not
go far enough to hit the deficit target and that “the government will
need to find at least E5 billion more.”

For Natixis chief economist Patrick Artus, a E45 billion plan would
be needed to hit a 3% deficit, given the surge in unemployment and the
risk of recession.

“With E40 billion, you’re sure of achieving 3% but perhaps with a
recession as well,” Barbet cautioned. “If you can hit the target and
avoid a recession, that would be preferable after all.” Moreover, the
government is likely to put several billions of budgeted expenditures on
ice at the start of the year to give it some leeway, he reminded.

With economic activity stagnant, some analysts argue that delaying
the deficit deadline would make economic sense. “One can ask whether a
target of 3% is really optimal for the French and Eurozone economies in
the current situation,” Barbet said.

Spain and Portugal have received a reprieve from Brussels and
Greece may as well. But France, as one of the last standing pillars of
the Eurozone, could hardly make a convincing case for special treatment
as long as its economy is still afloat, Caffet said.

Instead, “France should find a subtle way of missing its target:
announce 3%, pretend to be serious and come in at 3.5%,” Caffet quipped.
“That would already be not bad.”

And the risk of market sanctions? “If markets recognize that the
most sustainable trajectory is one that takes an extra year, I think
there will be no problem,” the analyst ventured.

This is a risk the Socialists are apparently willing to take.

UBS analysts also played down the risks of a modest deficit
overshoot: “As long as the government is committed to fiscal
consolidation and it takes the steps to show that the fiscal deficit is
on a downward path, the markets will likely continue giving France the
benefit of the doubt,” they wrote.

“This is all the more likely if the weak GDP/fiscal slippage story
is widespread across Europe and especially if, as we expect,
Keynesianism becomes fashionable again,” they added.

–Paris newsroom +331 4271 5540; email: ssandelius@mni-news.com

[TOPICS: MT$$$$,M$X$$$,MGX$$$,MFFBU$,M$F$$$,MFX$$$]

• Labor market is front and center

That was made clear by Chairman Bernanke in yesterday’s presser…

FRANKFURT (MNI) – German Chancellor Angela Merkel and Italian Prime
Minister Mario Monti spoke by telephone Friday, agreeing it was a “good
week for Europe and the Euro,” according to a statement from the German
chancellor’s spokesman.

The two leaders also agreed to remain in “close contact” ahead of
the EU leaders’ summit October 18-19, as the Eurozone works to build a
closer economic and monetary union, spokesman Steffen Seibert said.

– Frankfurt bureau: +49 69 720 142; email: ccermak@mni-news.com –

[TOPICS: M$G$$$,M$X$$$,MGX$$$,M$I$$$]

EUR/USD in consolidation mode now after a week of frantic short-covering took us well beyond what few but the most bullish traders saw possible this week.

Buyers are seen around the 1.3120 level, a top for a time earlier in the session.

More are seen toward 1.3080.

Light resistance is seen at 1.3180 near-term Heavier resistance does not come into play until 1.3280.

• Troika, Cyprus must speed up bailout talks

A tiny economy, so its bailout won’t move the needle much in terms of EUR/USD sentiment.